June 29, 2007

CME CEO Craig Donahue sent on some thoughtful remarks on the evolution of financial market structure that he gave at an International Monetary Conference that merit some comment.

A crucial point he makes is how demutualization has changed the nature of the relationship between exchanges and intermediaries, notably the large FCMs. Whereas the FCMs were once exchange members, and hence owners, and exchange efforts were devoted in part to enhancing their profits, now exchanges are focused on maximizing returns to shareholders. This, as Donahue puts it, creates a tension between “value chain players” with exchanges and intermediaries both chasing dollars from ultimate customers. Although this is not a zero sum game, exchanges can profit at intermediaries’ expense, and vice versa. Exchanges and intermediaries provide complementary services, and each is striving to get the biggest piece of what customers are willing to pay to execute and clear a trade.

This is not to say that these conflicts never existed. Donahue notes that non-profit exchanges were “inefficient member-run utilities.” In large part, that inefficiency was a feature, not a bug. Inefficient, committee-dominated, deliberative decision processes were in large part a way of managing tensions and conflicts and rent seeking between different types of exchange members, such as FCMs, floor brokers, and locals, all of whom were “value chain players,” and each of whom had an incentive to seek rents from other parts of the value chain. Thus, the tensions between exchanges and intermediaries are just now more out in the open. They used to be all in the exchange member family, as it were, but we all know that intra-family disputes can sometimes be very intense indeed. (I saw some of these battles up close when I worked with the Chicago Board of Trade to redesign its grain futures contracts, first in the early 1990s, then in 1997. I saw short hedgers pitted against long hedgers, Locals pitted against brokers, etc. Committee gridlock was intended in part to ensure that nobody could do anything to drastically change the status quo, and hence reallocate profits from one group of members to another.)

Donahue also notes that in the demutualized world, exchanges are venturing into the intermediaries’ space (e.g., the CME FXMarket Space and Swapstream) and intermediaries are striving to execute trades, either through internalization or the creation of execution platforms. He pays particular attention to the issue of “dark pools,” a subject that Clara Furse has been quite outspoken on as well.

Dark pools are off-exchange execution vehicles. Importantly, they typically do NOT contribute to price discovery, instead allowing large traders to execute orders at prices derived from those established on the exchanges where price discovery does occur.

Donahue (and Furse as well) raise concerns about the impact of this fragmentation on price discovery and the liquidity of exchange markets. The basic idea–which has been understood for quite awhile–is that dark pools (once called “third markets”) siphon off uninformed traders who provide liquidity from exchanges. This exacerbates the adverse selection problem on the central exchange market, leading to wider spreads and lower depth. The dark pools free ride off of exchange price discovery, and actually impair the quality of that price discovery by reducing the amount of trading activity that occurs on exchanges where the price discovery actually takes place.

It is quite correct that fragmentation impairs liquidity on central exchanges where price discovery occurs. It may be going to far, however, to conclude that this is inefficient, at least relative to the alternative of discouraging the formation of dark pools/third markets. Third markets may be second best, as I argued in a paper with a similar title, and in an article published in JLEO in 2002.

The argument is that central exchanges are likely to possess market power due to the network effects of liquidity. The existence of exchange market power means that we are not in a first best world, and hence the theory of the second best implies that an externality (such as free riding off of exchange prices) does not necessarily reduce welfare relative to what it would be if the externality was eliminated. (If absent the externality the exchange would supply the optimal level of output, the externality would reduce surplus.)

In the formal model in these papers the dark pools/third markets actually increase total surplus because they result in increased trading activity–trading activity that would be too small in the absence of the third market due to the output-restricting policies of exchanges with market power. The defection of some traders to third markets indeed reduces liquidity on the central locus of price discovery, making the traders on the central exchange worse off, but in the model the defecting traders reduce their trading costs (price impact costs) by an amount that is larger than the increase in trading costs on the exchange.

Thus, theoretical models do not support a blanket conclusion that fragmentation and free riding on exchange price discovery is a bad thing. I acknowledge that these results are dependent on the assumptions underlying the model, and that different results might obtain with different assumptions. The models do serve to caution us, however, that fragmentation is not necessarily a bad thing if competition between exchanges is imperfect, as is almost certainly the case due to the centripetal force of liquidity that tends to make price discovery a natural monopoly.

In my view, the dizzying pace of change in market structure in derivatives and securities trading is a very complex phenomenon. Moreover, it is very difficult to draw hard and fast conclusions about the desirability of various alternative arrangements because network effects and the information-intensive nature of trading mean that the “perfect competition” benchmark of textbook economics is not achievable in financial markets. All alternatives involve trade offs, and arguments over which arrangement is second best, third best, fourth best . . . . The devil is truly in the details, and it is very important to understand the microfoundations of trading. Different formulations of those microfoundations can lead to very different conclusions. The formulation of the microfoundations in my models leads to one conclusion–other formulations might lead to opposite implications.

In such an environment, it is important to have vigorous–and thoughtful–debate so that the relevant issues and trade-offs can be identified and evaluated. Craig Donahue’s speech is a fine example of such a thoughtful contribution, and I encourage anyone interested in the evolution of financial markets to read it when it is published (as I understand it will be soon.) In the meantime, it has reinvigorated my interest in these issues, and I will devote some effort to pushing the theoretical envelope to help gain a better understanding of how fragmentation affects welfare under alternative assumptions about microfoundations. My earlier work was inspired by mutualized exchanges that exercised market power by limiting membership rather than by charging supercompetitive prices for their services. Things may be different in a demutualized world where exchanges have an incentive to encourage entry of liquidity suppliers, and exercise market power by charging higher prices rather than by limiting access. The key thing will be to come up with models of such exchanges that predict that dark pools will form in equilibrium (as is clearly the case), and then to see how trading costs and trader surplus depends on policies affecting the operations of third markets. So many interesting problems, so little time!

June 17, 2007

In Whither NYMEX and Merc+Merc I surmised that NYMEX would not survive long as an independent entity. Earlier this week, that conjecture came much closer to reality. The exchange’s Chairman, Jim Newsome, made remarks that put NYMEX in play. Then Bloomberg’s Matthew Leising broke a story saying that NYMEX was in preliminary talks about a sale with three exchanges–Deutsche Borse, the NYSE, and CME.

NYMEX has strengths–its energy futures franchise–and weaknesses–notably the fact that it does not own its electronic trading platform. Each of the named suitors can fix the latter problem.

Who is going to prevail? I would put DB a distant third. Its activist shareholders (e.g., Atticus Capital) have been sharply critical of the exchange’s run at the LSE, and its offer to purchase the ISE. If they are furious with the $2.8 billion offer for ISE, I imagine they would be apoplectic over shelling out $14 billion or so for NYMEX.

CME is the most natural fit. NYMEX contracts already trade on GLOBEX (with 80 percent of crude contracts traded electronically on that platform.) This would dramatically reduce the integration problems. Moreover, a combination with CME would generate additional scope economies in clearing.

The NYSE’s John Thain has made it abundantly clear that he wants to buy his way into the derivatives market. Given the increasingly competitive environment in equities post RegNMS, and the continued spiraling growth in derivatives, this is very wise. NYMEX would be a good–but very pricey–way to do that. NYSE has the dough to deal. There could be some decent clearing economies via LCH.Clearnet. The integration might be somewhat dicier than with CME, but probably not an insuperable obstacle. But I think the main thing is that NYSE is going to do what is necessary to buy a big derivatives exchange–including overpaying for one. I get the sense that CME is not going to overpay just to do a deal, so the NYSE’s intense desire to get into futures could be decisive.

So, this could turn into an interesting battle between two heavyweights–NYSE and CME. How will it turn out? Here are my thoughts.

First, things will get very interesting after July 9, when the CBT and CME shareholders vote on the merger. This will resolve a lot of the uncertainty that makes prognostication difficult. If, as I expect, the shareholders approve, CME could well turn its sights on NYMEX. This could set off the battle with NYSE. Or, more likely in my view, NYSE will turn its gaze to ICE. Thus, the most likely scenario in my view is that there will be a CME/CBT/NYMEX combo and a NYSE/ICE pairing.

Second, things could get crazy if CBT shareholders reject the CME offer. If ICE gets CBT (no certainty), CME could turn immediately to NYMEX, or CME could try to swallow ICE. Or NYSE could go after ICE. I still think that the advantages of a CME-CBT combination are so compelling that one way or the other that the CME will get CBT, perhaps with ICE in the bargain. If that happens, NYSE would likely end up with NYMEX.

Third, after July 9th, it is likely that CBOE’s status will become clearer. Once the issue of CBT member trading rights on CBOE is resolved, CBOE will be in play. I think that it will end up with NYSE.

Fourth, once NYSE buys a US futures exchange–whether it’s NYMEX or ICE–it will be interesting to see how that changes the regulatory dynamic in the US. Securities exchanges and derivatives exchanges have always been at loggerheads over regulatory issues. Futures exchanges have wanted to stay away from anything that would put them under SEC oversight. Indeed, this is one reason why CME has disavowed any interest in CBOE. Once the NYSE gets a futures exchange, it will be interesting to see whether their attitude towards the SEC, and their support of a single regulator of stock and futures markets, will change. I imagine that it very well may. This is a very complicated issue, and there is no way that I would venture bold predictions. Suffice it to say that the consolidation of exchanges, and specifically the convergence/consolidation of derivatives and securities exchanges, will have major effects on US regulation.

In sum, we are nearing the culmination of the restructuring of US exchange markets. The weeks and months following July 9 will see a profound, and in my view rapid, reorganization of these markets. Moreover, the Road to the Final Two (exchanges) will run through Chicago because a major likely acquirer–CME–and a major likely target–CBOE–are there. (Yeah, I know it will run through New York too because major acquirers and targets are there too, but I gotta give props to my home town.) My bet is that when the dust clears, we’ll see CME+CBT+NYMEX and NYSE+ICE+CBOE.

[One aside. What about the two remaining US futures exchanges, MGE and KCBOT? They’ve done pretty well lately, but on purely economic grounds, in an electronic era it doesn’t really make sense that they remain independent entities. But their survival was always something of an anomaly anyways. CBT could have probably put both out of business by offering competing wheat contracts any time it chose. But it didn’t. Why not? Politics is a likely explanation. The value of the MGE and KCBOT to the CBT as political allies with influence on the Minnesota and Missouri congressional delegations far outweighed any value that the Chicago exchange would have gained by taking away volume from their relatively small wheat contracts. That might change once NYSE gets into futures. That would transform the NYSE from a political adversary of the Chicago exchanges to a frequent political ally. With the NYSE’s clout added to Chicago’s clout, the political value of the Minneapolis and KC exchanges will decline precipitously. If my political economy explanation for their survival to this point is correct, I would expect their days as independent exchanges to end soon after NYSE gets into futures in a big way, and sees its future growth coming more from derivatives than equities.]

My post discussed the point that the nub of the issue was that messages (i.e., bids, asks, cancels) were unpriced resources, and that as a result customers send too many of them. This has apparently dawned on some important folks. The article quotes the NYSE’s John Thain as saying: “We don’t get paid for messages, we get paid for trades,” Thain said. “So nobody has infinite message traffic capacity.”

Well, yeah, dude, but that sort of begs the question–is it optimal (or even sane) to have unpriced messages? Similarly, it begs the question–how do you know the right amount of message traffic capacity to invest in if there is no market for it? It is ironic (or something) that businesses that are in the business of facilitating price discovery haven’t thought more seriously about discovering some prices for their most important resource.

As noted in the original post, it is not a trivial matter to devise a capacity pricing system. As Coase noted long ago, there are costs to using prices to allocate resources. But there can be costs of not using them too. And there has to be some means of allocating a scarce resource (capacity) even if one doesn’t use prices. The article suggests that the costs of inefficient utilization of, and investment in, capacity may be very large. It mentions October 87, when capacity limits nearly caused a catastrophe in US markets. The TSE’s recent embarrassment is another illustration. I therefore think it is past time for exchanges to think seriously about capacity allocation mechanisms, including pricing mechanisms.

June 12, 2007

After almost 8 months, the Justice Department’s Antitrust Division finally weighed in on the CME-CBT merger. And the verdict? A green light.

Here’s the press release. The DOJ’s reasoning is quite solid–and very similar to my initial take on the competitive implications of the deal. On market definition, the Feds reasonably concluded:

More specifically, the Division determined that although the two exchanges account for most financial futures (and in particular, interest rate futures) traded on exchanges in the United States:

* their products are not close substitutes and seldom compete head to head, but rather provide market participants with the means to mitigate different risks; and

* they are, absent the merger, unlikely to introduce new products that compete directly with the other’s entrenched products, in part due to the difficulty of overcoming an incumbent exchange’s liquidity advantage in an established futures contract.

Good for them, not falling for the “US futures” market definition that the deal’s opponents were pushing. It is particularly interesting that the DOJ recognizes that execution is not highly competitive due to the incumbent’s liquidity advantage.

On clearing, the DOJ didn’t buy in to the fungibility argument:

Finally, the Division investigated whether the combination might foreclose entry by other exchanges into financial futures as a result of the integration of virtually all financial future contracts into a single clearinghouse. The evidence indicates that neither the clearing agreement nor the transaction will foreclose entry by other exchanges. Indeed, the New York Stock Exchange, in connection with its acquisition of Euronext.liffe, recently announced its intention to offer futures products, and the Intercontinental Exchange (ICE), in connection with its bid to purchase control of CBOT, has publicly stated its intent to offer interest rate futures regardless of whether its bid succeeds.

In a nutshell, the Division did not base its decision on the Chicago School argument, or the efficiency gains associated with integration. Instead, it noted that integrated entry (by ICE or NYSE/Euronext.LIFFE) was a viable form of competition. This is hard to square with the earlier statement that incumbent exchanges are largely immune from entry, but the logical outcome is the same. If execution is not highly competitive (due to an incumbent’s liquidity advantage) then integration with clearing will have little impact on entry by either integrated or non-integrated exchanges. Even though the reasoning here is a little shaky, the conclusion is the right one; the arguments against “silos” were not a reasonable justification for scotching the deal.

All in all, the Division is to be complimented. There was a lot of political heat to make the opposite call, and there were rumblings in the press that they would do so. They resisted this pressure, and made the right decision. The merged exchange will have market power, no doubt. But the CBT and CME had market power before any combination, and the relevant consideration is whether the merger would have reduced competition substantially. The DOJ does not have the authority to remake the futures industry and mandate the massive changes that would be necessary to enhance competition in clearing and execution. It had the limited authority to challenge this transaction if it deemed that it would reduce competition. It was my view from the outset that it would not, and I am pleased to see that the Division arrived at the same–and proper–conclusion.

So where do things go from here? In my initial take on the ICE offer, I stated that Sprecher was essentially long an option on the DOJ nixing the CME’s offer. That option just expired out of the money. ICE will probably not go away, but in my view the only way they can win the CBT is to overpay.

The interesting dynamic here is that unlike most takeovers, many of the shareholders of the target are also customers, so price is not the only consideration; customer/shareholders have to consider the cost savings and other benefits to their businesses that the combination will provide. Given that these benefits are clearly larger in a CME-CBT tieup than an ICE-CBT deal, ICE has to do much better on price than CME to prevail. CME can always trump the ICE bid because of this cost advantage–unless, as I said, ICE way overpays. (It is likely this realization that is behind the increases in ICE stock price when its prospects for prevailing worsen, and vice versa. This also interjects a weird dynamic into valuing the deals. When the ICE prospects wane, its stock price goes up, which makes its offer look more attractive. Mind bending.)

One wildcard is that these benefits do not redound to non-customer shareholders–hence the lawsuit by a Louisiana police retirement fund. This does raise interesting questions. It is easier to establish fiduciary duty when shareholders are homogeneous, than in the present instance where they are not. When shareholders are not consumers of the entity’s services, only price should matter. CME-CBT may be a better deal for the customer-shareholders (essentially the CBT members) even though the price is lower than what ICE is offering, but it may not be a better deal for the traditional public shareholders.

The economics of the CME-CBT combination are so much more compelling than the competing ICE bid, however, that it is likely that this obstacle can be overcome (unless ICE does something really stupid and way overpays). It may require a little creative financial engineering, or perhaps a settlement of the suit, or perhaps a further increase in the CME bid, but at the end of the day the gains from trade are sufficiently large to allow a structure that makes everybody better off. Traders being traders, there will probably be a lot of posturing and denigration of the CME bid by CBT shareholders in an attempt to get the Merc to bump up its offer. There will be stories about how the CBT holders will reject the deal. I would short those stories. CME may agree to increase its offer modestly in order to appear responsive, but even if it doesn’t, I fully expect that on 9 July both companies will agree to the deal, and that it will close shortly thereafter.

When that happens, an illustrious era will end, and another era will begin. I think that this will be good for the business, and good for Chicago. The coming years will be interesting, with complex interactions between exchanges and the OTC market (and a likely blurring of the lines between the two), and equally complex interactions between global markets. Let the games begin, and keep an eye on SWP for my take on the future of futures.

June 11, 2007

Vladimir Putin’s domestic popularity is traceable in no small way to Russian disgust with the outcome of the economic “reforms” of the 1990s. David Satter’s Darkness at Dawn provides an illuminating discussion of this subject.

The most interesting thing to me is Satter’s characterization of the mindset of Yeltsin’s “Young Reformers.” According to his account, these would be capitalists who loudly denounced communism were in fact still in the intellectual thrall of Marxist/Soviet conceptions of the free market and capitalism. In particular, they believed that (a) capitalism requires the accumulation of large private fortunes, and (b) in the developmental stages of capitalism, all such fortunes are acquired through theft. They also believed law to be merely the handmaiden of the powerful. Thus deluded by the errors of the very theory that they purported to destroy, they turned a blind eye to–nay, encouraged–the massive theft of state property. How property came into private hands was of little matter to them–only that it did so. They paid little attention to the creation of a legal and institutional framework necessary for the operation of a market economy.

Russia paid the price for this intellectual error, and are paying it today. Their crypto-Marxist strategy of the transition to capitalism (done in the name of anti-communism) discredited the market, and paved the way for Putin’s current “vertical” strategy.

Satter’s account suggests the possibility that the intellectual–and moral–inheritance of seven decades of Soviet rule (following centuries of Czarist absolutism and the patrimonial state) made a successful transition to a market economy a near impossibility. If even the advocates of the market system in Russia were so intellectually ill-equipped to guide the transition, how could one expect better results from a more democratic system, or one led by survivors from the Old Regime. The institutions of the market economy are far more complex, and must be internalized by more than a self-identified elite, than most realize.

And as someone sympathetic to–but not a complete believer in–the Stiglerian belief that intellectual theories are irrelevant anyway, I also suspect that things would not have gone well even if Yeltsin’s economic team had not been the unwitting slaves of Marxist doctrine. The collapse of central authority and the existing economic institutions (as deformed as they were) invited rent seeking on a gargantuan scale–the wholesale grabbing of anything and everything of valuable by the strongest and most ruthless. In a society with a long tradition of autocratic, violent, and bloody rule, it was likely inevitable that in the post-Soviet state of nature, gangsterism would prevail.

Satter’s stories of the actions of managers of large corporations also provides a valuable illustration of the property rights economics concept of “residual right of control.” Oliver Hart models a residual right of control as the ability of a manager to siphon off the cash flow of an enterprise. Boy, did the directors and managers do that it a major way.

Former FRBNY President Gerald Corrigan made a call for cash settlement of credit derivatives in the event of a default. This WSJ article doesn’t state whether one of Corrigan’s rationales was that cash settlement would make credit derivatives less vulnerable to manipulation. (Nor did any of the other press coverage that I found via Google.) I hope not, as I blogged last year this is NOT a reason to adopt cash settlement. A cash settled contract is as vulnerable, and perhaps more vulnerable, to a market power manipulation as a delivery settled one. I would also note that cash settlement is viable only to the extent that there is a reliable, independent price discovery mechanism that can be used to determine the settlement price. An auction of defaulted securities, combined with cash settlement, will provide the price discovery mechanism, but will not reduce the frequency or severity of manipulation (of the corner/squeeze variety) of these instruments.

June 10, 2007

The Independent carries an article discussing the future of foreign energy investment in Russia. Overall, it is about as sympathetic a piece as you will read, outside of the rantings of Russian energy nationalists or their Russophilic Western fellow travelers.

There is one part of the article that deserves comment:

In fact, there are many in the international energy industry who, if asked, admit to seeing Gazprom’s takeover of Sakhalin-2 in a slightly different light. They have some sympathy for Russia’s view that Shell’s original deal was almost extraordinarily advantageous, if not actual theft, and reflected the special conditions of the Nineties. Russia was almost bankrupt; its leadership was weak, its energy industry was in disarray, and the international price of oil was $10 a barrel. It was a deal, they say, that could not last. That Gazprom is buying out Shell and shareholders will be compensated is, they argue, proof that times have changed. It is at least better than confiscation.

This is actually the woe-is-me conventional wisdom about Russian oil deals of the time, but it must be taken with a grain of salt–not to say a Siberian salt mine. Sure, Russia was in sad shape when the Sakhalin-2 deal was negotiated–but the world oil industry was in a pretty bad way overall. The quote above mentions $10/bbl oil almost in passing, but that is the salient fact that cannot be forgotten. Oil majors like Shell were facing lean times indeed with low oil prices, and no prospect for an improvement any time soon. They were sharply cutting exploration expenditures. They were also cutting headcount ruthlessly. Seasoned people left the business in droves, and they were not being replaced; this is reflected in the odd demographics of oil firms, which are laden with people on the brink of retirement and many new hires, but with a “missing generation” in the middle.

In this environment, oil majors were not swimming in cash to sink in Siberian wastes. Nor did they have a huge appetite for risk. And Sakhalin-2 presented substantial risks–both technological and political. Hence, no PSA–no dice. Russia was not in a great bargaining position, but Shell (or any other major for that matter) was not in a negotiating mood anyways. They weren’t looking for the upside in speculative ventures–they were only willing to commit capital under terms that strongly limited their downside risk. Russia didn’t have the cash to invest, and given the economic environment and shareholder pressure prevailing at the time, the majors were only going to put up the cash under terms like those in PSAs.

Put differently, it is highly unlikely that Russia would have had anything to expropriate but for the PSA. Shell invested at a time when the economics of big investments in oil were very shaky. The world changed in a big way, and now Russia wants to take the upside. Russia, and sympathetic ears like the Independent, and perhaps “many in the international oil industry” not too proud to smooch a little Kremlin keister to get on Vlad’s good side, emphasize only one part of the history of the time in order to
insinuate that any 90s deal bordered on theft–all in order to excuse a real theft.

I have written before that Shell did itself no favors with the cost overruns, and its failure to keep the Russians apprised thereof. Moreover, PSAs–which are effectively cost plus and option contracts–don’t provide the best incentives to control costs. But it is doubtful that anyone would have invested in Russia in the 90s when oil prices were at rock bottom without such a contractual guarantee that costs would be covered.

Furthermore, I might have more sympathy for the Russians if they had pursued their grievance against Shell in a more legally or commercially respectable way. Instead, they engaged in a shakedown that would have made any extortion racket proud. These illegitimate means–so redolent of the mafia style that pervaded (and pervades) so much of Russian political and economic dealings (read David Satter’s Darkness at Dawn if you doubt the veracity of this statement)–cast serious doubts on the legitimacy of the grievance.

So I’m not buying the revisionist line the Independent–and the Kremlin–are peddling.

Although Putin’s recent remarks about targeting Soviet (oops! I mean Russian) missiles at Europe drew the most attention in the runup to the G-8 (really the G-7 plus a poser), what struck me is the nature of Putin’s rhetoric. He is a master at “tu quoque”–“you’re another”–as his stock response to any critique. Any criticism of Russia is met by a “well you are not so perfect yourself pal, so get off my back” response. Put differently, Putin is eagle-eyed when it comes to spotting the specks in our eyes, all the while ignoring the beam in his own.

Tu quoque is a very disreputable rhetorical trick. It is a means of avoiding any serious discussion or debate. It is defensive–but offensive at the same time. It equates 1 percent and 99 percent–because neither is 100 percent perfect.

It is also emblematic of a particularly aggressive mindset, not surprising from a secret policeman, especially a Russian secret policeman. And especially a Russian secret policeman that also happens to be a judo expert. Judo fighters turn their opponent’s strength against them. One of the West’s strengths (as Victor Davis Hanson is wont to point out) is self-criticism and the “audit” of public servants. Whereas criticism of Russia usually sparks angry reactions, tu quoque triggers the Western self-critical response. This plays into Putin’s hands.

It is well to be self-critical, but it is also advisable to remember the difference between 1 percent and 99 percent (or even 50 percent), and not to let tu quoque from would-be totalitarians (or at least authoritarians) put us off from robust and steadfast opposition to their machinations.

Pipelines in the Caspian region bypassing Russia do not spell confrontation with the country’s energy giant Gazprom, a senior United States official said Wednesday.

Speaking at an oil conference in Azerbaijan’s capital, Deputy Assistant Secretary of State for European Affairs Matthew Bryza said the U.S. welcomed supplies to Europe via the well-developed pipeline network run by Gazprom, but that U.S.-Russia energy relations would only gain from robust competition.

I find it hard to believe that Bryza really believes this tripe. Pipelines bypassing Russia are all about confrontation with Gazprom. Moreover, “robust competition” will not improve US-Russia relations on any dimension. A serious effort to wrest some Central Asian gas from Russia/Gazprom strikes at the very heart of the entire Russian strategy. It will compromise its ability to meet its supply commitments to Europe. It will sharply reduce the fat margins that are the lifeblood of Gazprom and the Russian state. Given these realities, Russia will fight tooth and nail to protect its hammerlock on the Caspian. A serious battle will not put them in a good mood. And all the better for that.

So what’s the point of making such risible statements? Does he really think that such anodyne remarks will actually put the Russians at ease? If anything, such statements are likely to inflame the paranoia that characterizes so much of the Russian leadership. It’s all just diplospeak, you might say. Diplomacy is often built on polite fictions, but these fictions have to be at least slightly plausible. Bryza’s statements are anything but. In my view, a much more honest and straightforward approach would be desirable–and would more be more likely to get some respect from the Russians, as opposed to the derisive snorts that no doubt greeted Bryza’s remarks in the Kremlin.

This also illustrates a point that I made in an earlier post. Specifically, whereas Russia plays its A team in this game–with Putin spending an entire week in the region to seal deals–we have Deputy Assistant secretaries carrying the ball. And he’s speaking from Azerbaijan while Putin does business in Turkmenistan and Kazakhstan. And the Europeans are MIA altogether.

I guess it could be worse. We could have Deputy Assistant Undersecretaries leading the charge. But until folks at substantially higher pay grades are regularly engaged in the task of dealing with Caspian energy issues, Putin will continue to leave us in the dust.